MBIA, Bank of America reach $1.7bn settlement

MBIA, an insurance company that had been in danger of being unable to meet its obligations within a few months, has reached a $US1.7 billion agreement with Bank of America over disputes stemming from MBIA’s insurance of mortgage-backed securities that became troubled when the financial crisis blossomed. The agreement will cancel out the multibillion-dollar claims each institution had against the other.

Reports of a nearing settlement, first reported by The Wall Street Journal, sent MBIA shares soaring. By early afternoon they were up $US4.21, or almost 43 per cent, to $US14.04. Bank of America shares were up US56¢, nearly 5 per cent, to $US12.80 in New York Stock Exchange trading.

At the heart of the dispute were obligations taken on during the credit boom that preceded the crisis that began in 2008. MBIA wrote insurance on many mortgage securitisations and credit-default swaps that ultimately went bad, including obligations that seemed likely to force it to pay as much as $US3 billion to Merrill Lynch within a few weeks. The insurer claimed that it had been misled by Countrywide Financial, a mortgage issuer, regarding the quality of mortgages it was insuring, and sought as much as $US5 billion from Countrywide.

During the crisis, both Merrill Lynch and Countrywide were acquired by Bank of America. Without Monday’s agreement, it seems likely that MBIA would have been unable to meet its obligations to Merrill Lynch, and the regulator would have put at least part of MBIA into receivership.

MBIA originally insured municipal bonds, a profitable business because few such bonds ever defaulted and municipalities buying the insurance would get AAA ratings on their bonds, saving them more in interest payments than the insurance cost because many muni bond investors were very risk-averse.

It later expanded into insuring securitisations and writing credit-default swaps, businesses in which the purchasers were more sophisticated. When the financial crisis struck in 2008 and 2009, it became clear that the company had taken some very bad risks.

In 2009, the New York State Insurance Department, which later was folded into the Department of Financial Services, approved a decision by MBIA to split into two companies. One would insure only municipal bonds in the United States, still a relatively safe business. The other company would take over MBIA’s other obligations, involving securitisations.

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Banks and hedge funds that owned securities insured by MBIA went to court to try to reverse the split. In March, MBIA prevailed in one of those suits, as Justice Barbara R. Kapnick of the New York State Supreme Court ruled that the insurance department had wide latitude to approve the split with or without much investigation.

She cited a deposition by Michael Moriarty, the deputy superintendent of the department at the time, who said “the department did not, nor do they usually, verify the financial condition of a company." Since that was the policy, the judge concluded she had no authority to question it, even if some of the information provided by the company turned out to be false.

Bank of America had vowed to appeal that decision, raising the possibility that an appellate court would order a trial that could be embarrassing to the state regulator. Under the settlement, the bank will drop that appeal. A similar suit filed by hedge funds has been stalled and could be revived, but the settlement raises at least the hope that the split-up will be allowed to proceed.

MBIA has often expressed the hope that, with the split final, it might be able to again issue muni bond insurance.

Bank of America had purchased the bonds in an effort to frustrate MBIA’s effort to change their terms. By turning over the bonds to the insurer, it now seems likely MBIA can proceed. The expectation is that MBIA will eventually resell the bonds to investors, providing cash for the company.